Why do most of us send our credit-card bills to South Dakota or Delaware? The answer to that seemingly arcane question illustrates the dangers of replacing state regulation with no regulation at all. It also offers a cautionary tale about a little-understood provision at the center of John McCain's health care plan. So bear with me for a little history.
Until the late 1970s, South Dakota and Delaware didn't have an outsized share of the credit-card business. Banks had to obey the interest caps of the states where borrowers lived. So, for example, loans to New York residents were always subject to New York's limits on interest rates. At 12 percent back then, and with high inflation, these laws sharply limited profits on credit cards.
Then in 1978, the Supreme Court said banks should follow the rate cap in their home states. This meant that as long as a credit-card company relocated to a state with a higher interest-rate limit, the company could lend to borrowers anywhere under that higher limit. Following the court's ruling, Citibank chairman Walter Wriston offered Gov. Bill Janklow a deal: If South Dakota lifted its rate cap altogether and formally invited Citibank to the state (as federal law required), the banking giant would move its credit-card operations to South Dakota—along with 400 good jobs.
The bill was introduced and passed in the space of a day. Soon after, Delaware lifted its cap, too. Voilà, South Dakota and Delaware became the hosts of most credit-card companies. And with the help of another 1996 Supreme Court decision, credit-card companies could charge what they wanted.
The centerpiece of McCain's plan, as reporting in the New York Times has noted, would eliminate the special tax treatment of employer-provided health care and instead offer tax credits to everybody who pays premiums. In a less-noticed move, McCain also proposes to change the market for health insurance that people buy on an individual basis—he says that "families should be able to purchase health insurance nationwide, across state lines." That would be a big change. Today, insurance companies need to follow the laws of the states where they sell individual insurance plans, just as credit-card companies did before 1978. If an insurer wants to sell policies in New York, the insurer has to obey New York's laws. Many states pretty much let companies sell the policies they wish, but others set a floor of protections. New York laws, for example, require that companies issue coverage to all new customers and not set higher rates for people who are already sick. As Stephanie Lewis points out in a forthcoming paper for the Center for American Progress, 17 other states impose at least some similar regulations. These rules may increase premiums for healthy folks, but they also give people with pre-existing conditions a decent chance to afford health insurance in the market for individually purchased policies.
McCain argues that different states' regulations "prevent the best companies, with the best plans and lowest prices, from making their product available to any American who wants it." Although he hasn't given details, his supporters say that he favors an approach, endorsed by President Bush and championed by McCain's Arizona colleague John Shadegg, that would allow insurers to choose the state laws under which they are regulated. (I e-mailed the campaign about the specifics of McCain's approach and didn't hear back.) An insurance company that chose to be regulated under Arizona law could sell policies in New York without following New York rules. Arizona, like most states, lets companies charge what they want to people who are sick—or simply deny them coverage altogether. Under Shadegg's bill, insurers wouldn't even need to pick up and move their operations; it would be enough to file some paperwork with a state insurance commissioner and pay that state's relevant taxes.
If enacted, this proposal would cause a shift along the lines seen in the credit-card industry. Like the Citibank of old, New York insurers would have little incentive to continue doing business under New York's laws. Insurance companies can make bigger profits by offering different policies to different people based on separate assessments of risk rather than charging everyone the same, as a state like New York requires. An insurer operating under Arizona law would be able to offer healthy New Yorkers a cheaper policy than an insurer working under New York law that has to price policies the same for everyone.
Is that a good thing or a bad thing? In the credit-card industry, there's a pretty decent argument that the old usury laws restricted access to credit, even among people who needed it and could use it well. And competition among card issuers has led to a proliferation of rewards programs—frequent-flyer miles, hotel discounts—that work nicely for people who pay their bills in full and on time. There's also a classic libertarian argument for deregulating credit cards: MasterCard never put a gun to anybody's head.
The problem is that without consumer protections, companies use pricing practices, like teaser rates, to attract cash-strapped families and then slap those families with interest rates of 35 percent or higher plus penalties of $35 a month. Rates can double or triple without notice, even if you never miss a payment. Credit-card use and bankruptcy rose together for years (until the 2005 federal bankruptcy legislation), and last year, banks made $40 billion in plastic profits. For families drowning in debt (often from health expenses, by the way), a credit card may be the only life raft—but in the memorable words of Elizabeth Warren and Amelia Tyagi, authors of The Two-Income Trap, the raft turns out to be made of cement.
With the individual market for health care, the libertarian argument fails on its own terms: Sick people can't get coverage they can afford. It's as though the rafts are reserved for people who already have life preservers. Americans with pre-existing conditions—cancer, asthma, diabetes, and the like—would need to pay even more than they do today. Through no fault of their own, more of them would end up without insurance. Meanwhile, insurers would improve their own profits by offering targeted policies to people with the fewest health expenses. As with the history of credit cards, it's Robin Hood in reverse. Apart from the obvious injustice, this approach could add to spiraling health costs. The sickest 10 percent of Americans are already responsible for 70 percent of the nation's health expenses. When more such Americans go uninsured, skip checkups, and land in the emergency room, they end up costing taxpayers more.
In a national economy, there's often a good argument for standardizing rules across state lines. Smart reforms of the credit-card industry wouldn't reinstate the old regime of state regulations; they'd provide national protections against practices like raising rates for people who are paying their bills on time. In health care, federal law already sets a very low floor of protections for individuals who lose coverage. But many people don't benefit, because they don't already have coverage, don't qualify, or can't afford their new premiums. Sensible reforms in the market for individually purchased health insurance would apply New York-style rules nationally and then do more to bring down average costs: bringing small businesses into risk pools with individuals, using mandates or automatic enrollment to expand those pools, and deploying tax subsidies to make coverage more affordable.
What makes no sense is to neuter state regulations while putting nothing in their place. That will leave the sickest people, who drive the sickness of our health system, in more trouble than then are in now. Letting South Dakota regulate America's credit-card industry hasn't worked out so well. Letting Arizona do the same for health insurance would be worse.